E-Commerce Bubble- Myth or Reality

Posted in Marketing & Strategy Articles, Total Reads: 1450
, Published on 09 October 2015

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Ecommerce in India has become one of the most keenly watched sectors. With the investors in a gold rush to invest in ecommerce firms, the valuations of firms are reaching stratospheric levels. With every additional round of funding, the valuation keeps on surging. The focus is to increase revenues even if that comes at a cost of profitability. This has given rise to questions on the business model’s sustainability in the long run. Some experts are of an opinion that the Ecommerce in India is a bubble waiting to burst.

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E-Commerce Sector

The Ecommerce sector in India has witnessed tremendous growth in the past few years owing to the rapid technology adoption which was propelled by an increase in internet penetration and the growth of smartphones and tablets in India. It has grown by a CAGR of 34% from $3.8 billion in 2009 to $16.4 billion in 2014. It is projected to be worth $22 billion by the end of 2015.

Currently, online travel comprises 70% of the Ecommerce sector. But, Etailing has evolved as the fastest growing segment in Ecommerce. Etailing consists of online retail and marketplaces. It has grown at a tremendous CAGR of 56% over the period 2009-14. The size of the Etailing market is pegged at $6 billion in 2015. Books, apparels, electronics and accessories account for 80% of the sales through Etailing. [1]

Online retailing forms just 5 percent of the total retail in India. Hence, it is believed that there is a huge untapped potential in Etailing. [2]

According to a report by Tracxn, a Bengaluru based analytics firm, 14 hedge funds, investment firms and asset managers have pumped in $3.8 billion in the Indian technology and ecommerce startups since the last year. [3]

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Surge in Valuations

Flipkart was valued at$12.5 billion in March 2015 from its $1.6 billion in October 2013, which represents an eightfold jump in 18 months. Snapdeal’s valuation also surged fivefold from $1 billion to $5 billion. The reasons cited for the high valuations are the increase in the disposable income with rise of middle class and the increase in internet penetration with the growth of smartphones and tablets. This enormous growth in valuation of Ecommerce companies has led to a debate among industry experts. While many of the industry trackers agree about the high potential of Ecommerce in India, there is a lack of unanimity on the fairness of valuations.

A recent example of an arbitrage opportunity surfaced on a prominent Ecommerce website. A bullion supplier brought back the gold that he supplied to the online retailer, for a discount. This incident depicts the rush of the ecommerce companies to capture market share by offering heavy discounts on the products to win new customers. The problem with this model is the lack of commercial viability as this ‘cash burn’ is sponsored by the funding investors. [4]

Gautam Chhaochharia, the lead author of a UBS report on Ecommerce in India, the valuations are ‘rich’ according to the global standards and are based on the aspirations of growth of the sector. His analysis for the implied valuations of Indian internet companies reflects that they may be overvalued by $8 billion. A high premium is paid by the investors based on the expectations of exponential growth. [6]

According to the Ecommerce companies, the discounts are a means to acquire customers and slowly revoke the discounts offered in the long run. The customers will continue to shop, due to the convenience that Etailing offers.

The Etailing environment in India appears to be unsustainable. The following facts lend credence to this argument:

1) Lack of proper Government policy: There in no clarity on the policy that governs the Ecommerce sector in India. The government has not allowed FDI in B2C Ecommerce in India but there is no clarity about the policy in future. This lack of proper regulatory framework may lead to tax disputes and the companies facing undue scrutiny. [5]

2) Cash Burn: Etailers in India are currently “burning cash” by offering heavy discounts, incurring high marketing expenses and offering services like free shipping, cash-back incentives and cash on delivery options. According to a report by UBS Securities Ltd, Amazon, Flipkart and Snapdeal reported combined revenue of $85 million and a loss of $163 million in 2014-15. To simplify, these companies spent nearly $3 to revenue of $1. These losses can be attributed to rising operational costs and heavy discounts offered to the customers. [4][6]

3) Increase in data tariffs: The growth in ecommerce has been attributed largely to the increase in internet penetration through smartphones in India. With the telecom companies paying hefty license fees to the government in spectrum auctions, an increase in data rates across various operators is inevitable. Recently, Airtel and Idea increased their data tariffs in Delhi circle. This may stunt the growth of the ecommerce companies, many of whom are relying on the mobile platform for expansion. [7]

4) Price Sensitive Indian customer: One of the major reasons for the growth of Etailing firms in India has been the deep discounts that they offer to the customer. The categories like apparels, footwear and optical solutions have recorded a tremendous growth in recent past. These products in categories are generally bought after physical inspection and trying by the customer to find an appropriate fit. This also suggests that the primary reason to buy online is the discounts offered. It is highly debatable that the consumers will continue buying online even when the discounts are not offered.

The Ecommerce companies in India witnessed a steep fall in sales in Q1 of this financial year as they reduced the discounts. The companies fell far behind their projected sales figures. Although this drop in sales requires a detailed study, but this partly vindicates the argument of price sensitivity of the Indian consumer. [8]

Following Amazon

Amazon was started in 1995 and recorded its first profit in 2001. The message for the Ecommerce companies and the investors backing them is that it takes time to turn profitable, if all they do.

However, the focus on digital is helping Amazon to progress on the path to achieving profitability. EBooks now make up a multibillion dollar category for the company which are sold through Kindle devices. Amazon also provides digital content in the form of video and music streaming on these devices. Amazon has also diversified to offering Cloud based enterprise solutions through its Amazon Web Services (AWS) platform. It also diversified to commercial lending through Amazon Capital Services Inc. These strategies have led to the profitability that Amazon has achieved. Indian market with its low internet penetration, unclear tax regime and weak regulatory structure against piracy is not suitable for Web based services. Thus, replicating Amazon in India would be a monumental task for the Indian Etailing companies, if they intend to do so. [9][10]

Conclusion

Thus, the enthusiasm associated with Etailing in India appears to be based on overly optimistic prospects of the future. The Indian online buyer is the primary gainer from the ongoing price wars. The industry is already witnessing consolidation. It remains to be seen – How many (if any) online players survive this ‘cash bleeding battle’.

This article has been authored by Ayush Sethia & Udit Srivastava from IIFT Kolkata